How to Take Money From the Market Maker Presented by Andrew Keene

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Andrew Keene - Floor Trader @ CBOE 10+ Years Regular Contributor to CNBC & Bloomberg Taught thousands of students how to become full time traders Turned $50,000 into millions of dollars

Trade Like a Market Maker -This is the BEST time ever to trade Options: Markets are Tighter, Penny Wide, and More Liquid that Ever -There are 8700 stocks and 4200 stocks with options. -Of the 4200 stocks with options, there are over 320 stocks with listed weekly options Gives traders 52 expirations to trade instead of 12

Trade Like a Market Maker What is a Market Maker? A market maker is someone who is always quoting a bid-ask spread for a given option contract. The market maker is willing to take either side of the trade and is hoping to profit from the spread between the bid and offer. Example: AAPL is trading at $590.00 The market maker makes a market for the Dec 650 calls at 25-25.30 20 up. This means that at this given time the market maker is willing to buy 20 contracts at $25 and/or sell 20 contracts at $25.30.

Trade Like a Market Maker We will discuss: Who Controls Order flow Watching Institutional Order Flow Use the Market Makers Target for Iron Condors Learn Best Time of Day and Week to Trade Credit and Debit Spreads Learn when and why to Trade a Credit or Debit Spread Learn how to Potentially Profit 600% in Options Using Market Maker Targets

Trade Like a Market Maker Understanding Who Controls Order Flow: Does the market maker control order flow? Absolutely not! Institutional traders and investors are the ones who really control all of the order flow in the options market. But who are these traders?

Institutional Paper Mutual Funds, Pension Funds, Sovereign Wealth Funds The “whales” are the ones really in control of order flow

Institutional Paper Hedge Funds The more aggressive fish also control order flow. These orders come from hedge funds and big traders.

Trade Like a Market Maker Understanding Who Controls Order Flow: Why are these the people in control? They have MORE capital They have MORE access to information They have BETTER technology They can take on MORE risk These are the traders we want to follow. These are the traders the market maker watches.

Using the Scanner in the Trading Room: How will follow and watch Order Flow

Using the Scanner in the Trading Room They talk about unusual options activity all the time on CNBC and other options shows all the time. Why?

How We Trade Trading Unusual Options Activity: We have a scanner that shows us every block trade from every options exchange. We watch over 2,000 orders hitting the tape everyday and look for the most “unusual” trades Market makers look at the same things What do these orders look like?

Unusual Option Activity Example Trade Size Symbol Expiration Implied Vol @ the Time Strike Type Price Traded 11:20:10   11,500 GERN Oct 2 Puts $.11  ON BID   IV=96.9%    AMEX 311 x $.10 - $.20 x 1390 OPENING   GERN= $2.19 Time Stamp Exchange & Bid Ask @ the time Opening or Closing Position Where stock was trading When the option trade happened Bought or Sold *Red Sold Green Bought

What Makes the Order Unusual? Trading Unusual Options Activity: The block trade is considered “unusual” if the option volume is above the average daily volume over the past 22 days. Analyzing unusual order flow gives traders a window into what the positions that large institutional players have. Order flow can however at times be deceiving. One might logically thing that a large block buyer of calls is bullish on the underlying. This is not always the case

Using the Scanner in the Trading Room Trader Buys Calls: Is it a Hedge or Speculation? Trader Sells Calls: Protection against long stock position or speculation to establish short position. Trader Buys Puts: Protection against long stock position or speculation to downside? Trader Sells Put: Protection against stock stock position or speculation to upside?

Using the Scanner in the Trading Room Paper Buys Calls : 60% - 40% Bullish / Bearish Paper Sells Calls : 50% - 50% Bullish / Bearish Paper Buys Puts : 65% - 35% Bullish / Bearish *Paper Sells Puts : 80% - 20% Bullish / Bearish

Using the Scanner in the Trading Room Because order flow can be deceiving market makers look for patterns in the order flow. On a daily/weekly basis is the order flow more bullish or bearish. If institutions are consistently buying calls day in and day out it is more likely to be a speculative bet. We’ve seen this happen in stocks like ECA, VLO, TSO and BWP. Relentless call buyers Looking where open interest sits can also help make this determination

Notice how thin OI is on the Put side See all of the open interest on the call side? Take note as well that the OI is in ATM and OTM Options

Using the Market Makers Targets for Iron Condors and Iron Butterflies: Using Smarter Targets For Income Strategies

Using the Market Makers Targets for Iron Condors and Iron Butterflies Traders can use the price of the at the money straddle to calculate how much market makers think the stock can move by expiration. This can be easily calculated using the price of the at the money straddle. Traders can use this to calculate implied closes for that expiration.

Using the Market Makers Targets for Iron Condors and Iron Butterflies The Goldman Sachs Group, Inc (GS) was reporting earnings on 4/17/2014 Before the market open. I thought that the stock wouldn’t move much so I wanted to set up a short premium position. Why did I think this? I looked at the historical performance of GS on earnings.

Using the Market Makers Targets for Iron Condors and Iron Butterflies Date       PreEarn PostEarn     Change 01/16/14  $178.75  $175.17  $-3.58 (-2.0%) 10/17/13  $162.25  $158.32  $-3.93 (-2.4%) 07/16/13  $163.00  $160.24  $-2.76 (-1.7%) 04/16/13  $146.46  $144.10  $-2.36 (-1.6%) 01/16/13  $135.59  $141.09  $+5.50 (4.1%) 10/16/12  $124.50  $123.22  $-1.28 (-1.0%) 07/17/12   $97.68   $97.98  $+0.30 (0.3%) 04/17/12  $117.73  $116.86  $-0.87 (-0.7%) Historical Earnings Move: Mean 1.7%, Median 1.7%

Using the Market Makers Targets for Iron Condors and Iron Butterflies The GS Apr ATM 157.5 Straddle was trading at $3.70. This tells me that the stock can move up or down by $3.70 BY EXPIRATION. Using this straddle price we will calculate our upside and downside targets: Upside Target = $157.50 + $3.70 = $161.20 Downside Target = $157.50 - $3.70 = $153.80 I now have an implied range that I can use to set up a trade

Using the Market Makers Targets for Iron Condors and Iron Butterflies Using the Measured Move Targets to Set Up an Iron Butterfly: My Trade: The GS Apr 155-157.5-160 Iron Butterfly for $2.00 Credit Risk: $50 per 1 lot Reward: $200 per 1 lot Breakeven: $155.50 and $159.50 This trade has a GREAT reward/risk set up and has a wide range of profitability. Let’s see how it played out…

Using the Market Makers Targets for Iron Condors and Iron Butterflies The SPY is currently trading around $188.50 I will look at the weekly 188.50 straddle to get targets. The Weekly 188.50 Straddle is trading at $1.30 Upside target = $189.80 Downside Target = $187.20 Now let’s look at a trade set up…

Using the Market Makers Targets for Iron Condors and Iron Butterflies Trade: The SPY Weekly 186.5-187.5-189.5-190.5 Iron Condor for $0.35 Credit Reward: $35 per 1 lot Risk: $65 per 1 lot Breakeven: $187.15 and $189.85 This trade makes money if the SPY closes anywhere between $187.15 and $189.85 on expiration. This trade also sets up well on a risk vs. reward basis

When Is the Best Time to Trade Credit vs. Debit Spreads When Is the Best Time to Trade Credit vs. Debit Spreads?: Capturing the Most Premium and Avoiding Time Decay

When Is the Best Time to Trade Credit vs. Debit Spreads? When is the best time to buy a car? When you are shopping for a car when is the dealer more incentivized to give you a good deal? At the beginning of the month your less likely to get a good deal. At the end of the month they have quotas to meet. Think about that while we discuss how market makers think about premiums during the week.

When Is the Best Time to Trade Credit vs. Debit Spreads? Market makers know the best time of the day and week to trade credit spreads and debit spreads. On Thursday morning I will begin selling out some of my long premium positions Thursday afternoon is when market makers begin “rolling their date forward” What does this mean?

When Is the Best Time to Trade Credit vs. Debit Spreads? Thursday afternoon is when premium really starts to come out of options but when do I want to be putting on debit spreads? I know that I want to be buying debit spreads on Tuesday afternoon This is the best time of the week for me to put on long premium positions Why?

Why Trade a Credit Spread vs. Debit Spread Why Trade a Credit Spread vs. Debit Spread?: Know Which Stocks Work Best For Credit vs. Debit Spreads

Why Trade a Credit Spread vs. a Debit Spread? Changes in a stocks trend and price action can change our considerations when looking to trade credit or debit spreads. Some things to think about: Is the stock in a range? Is the stock a trending stock? Is the stock breaking any key levels? Lets look at some chart examples….

As stock breaks key level here implied volatility explodes As stock breaks key level here implied volatility explodes. Now we are looking for debit spreads When inside this range we want to be trading credit spreads

This type of trend is very strong This type of trend is very strong. We want to be trading debit spreads on charts like this. With stock at $35 I could get long 2 ways: Buying Front Month 36-37 Call Spreads for $0.30 Selling the Front Month 34-33 Put Spreads for $0.30 Which setup had a better return?

Using the Market Makers Targets to Potentially Make 600% Profits: Us Smarter Targets to Set Up Low Risk High Reward Strategies

Using the Market Makers Targets to Potentially Make 600% Profits We talked about how we can use the market makers targets to find levels for Iron Butterflies and Iron Condors. We can also use these targets for more speculative trades. We will look at how to use them to set up low risk high reward strategies called Call and Put Butterflies. We trade these strategies ahead of earnings announcements or other catalyst events.

Using the Market Makers Targets to Potentially Make 600% Profits Earnings Trade in SWKS: SWKS is reporting earnings on 4/22/2014 After the bell: Stock was trading around $37.00 The Apr 25th 37 Straddle was trading around $4.00 The chart was looking very bullish We calculate an upside target of $41.00

Using the Market Makers Targets to Potentially Make 600% Profits My Trade: I bought 15 SWKS Apr 25th Weekly 39-41-43 Call Butterflies for $0.38 Risk: $38 per 1 lot Reward: $162 per 1 lot Breakeven: $39.38 and $42.62 This trade has a better than 5-1 reward to risk set up but it is typical to see setups with a 6-1 or better setup.

Shares of SWKS gap higher right to the measured move target

Using the Market Makers Targets to Potentially Make 600% Profits On Friday I was able to sell my SWKS Call Flys for $1.60 or 500% Profits. These are huge profits and the reason this trade worked out so well is because I had great targets calculated using the straddle. This is how market makers develop targets and it works better than anything else out there.

Using the Market Makers Targets to Potentially Make 600% Profits Butterflys to Get Short: TWTR is reporting earnings on 4/29/2014 After the bell: Stock was trading around $43.50 The May 2nd ATM Straddle was trading around $6.00 The chart was looking very bearish, broken We calculate a downside target of $37.50

Using the Market Makers Targets to Potentially Make 600% Profits My Trade: I bought the TWTR Weekly 40-37-34 Put Fly for $0.45 Risk: $45 per 1 lot Reward: $255 per 1 lot Breakeven: $39.55 and $34.45 This trade has a better than 5-1 reward to risk set up but it is typical to see setups with a 6-1 or better setup.

Confidence Scale Andrew Keene’s Confidence Scale: How I size trades and Manage Risk 5: Least Confident Trades: Often Weekly Options and Spreads 4: Front Month Positions 3: Positions that are 2-6 Months from Expiration 2: Positions that are 4-8 Months from Expiration 1: Most Confident Trades

Summary Institutional traders are the ones who control the market. These institutions are hedge funds, mutual funds, pension funds and big banks. Traders can spot trends in the put/call ratio to determine what the overall sentiment of the options market is on a given stock Market makers targets are far more accurate than price targets developed using fib levels or other technical analysis methods. Traders can use these targets to trade Iron Condors and Iron Butterflies around catalyst events or for income strategies. Thursday morning is the best time to sell premium before market makers “roll their date forward” We only want to trade credit spreads in trading range stocks, if they breakout we become debit spread traders. We want to trade debit spreads in trending stocks

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